Make or break at Madrid

Date: 05/10/1995

By Tim Jones

THE coming eight weeks could determine whether December's Madrid summit will be remembered as the defining moment in the creation of a single currency or the scene of its burial.

With as much as 10 billion ecu of investment required in new computing systems, retraining and marketing, Europe's banks need to know one way or the other. “At the latest in Madrid, we need a binding scenario under which a switchover will be done,” says Nikolaus Bömcke, Secretary-General of the Banking Federation of the European Union. “We must know whether to make such heavy investments.”

Last weekend's informal meeting of EU finance ministers (Ecofin) and central bank governors in Valencia started to put some flesh on the bones of what the transition to a European currency will look like and surprised many with its success.

Over the previous two weeks, unguarded comments from German Finance Minister Theo Waigel and the fierce market reaction they provoked seemed to have endangered the project so carefully constructed in Maastricht back in 1991.

But, in just one day of talks, ministers revived the plan. Countries ready and willing to join the monetary union will fix exchange rates and create a central bank from 1 January 1999, after a summit decision in late 1997.

With the 'when' question decided, a compromise reached by the 15 central bank governors the previous Tuesday (26 September) at a meeting of the council of the European Monetary Institute (EMI) answered key elements of the 'how'.

Once the decision is taken to fix exchange rates, the EMI will have a year to set up the joint central bank to assume monetary policy powers and carry out all its business in the new currency from 1999.

Banks will be allowed to switch to European currency for the making of loans and accepting of deposits between each other and other financial institutions (the so-called “interbank” market) from day one, but the general public will continue to use national money.

Three years later, banknotes in the European currency will be issued and circulated parallel with national notes for six months before assuming sole status as legal tender.

This much is agreed.

The next EMI council meeting on 7 November aims to put the finishing touches to a report on the outstanding issues in time for the 27 November Ecofin in Brussels. Officials hope this will allow the summit on 15-16 December to resolve this issue, once and for all.

As the Madrid deadline approaches, the pace of sub-ministerial work is speeding up. Special working groups of the monetary committee are ploughing through texts on how to define the legal status of the new money and when governments should start switching their debt away from national currency.

Only the name of the European currency is being left to the heads of state and government. The Germans have now agreed on the name 'Euro' as their favourite, but other governments are taking their time to commit themselves and are likely to wait until Madrid before making their final choices.

What Valencia also made clear is that the group of countries going into the monetary union will be small and selected on Germany's terms.

If Waigel's off-guard comment that Italy would not be in the first rank of monetary union and members achieved anything, it was this.

Finance ministers queued up to pledge that they would continue to follow the path of “convergence” even a decade after they joined the union. Germany is still to come forward with its proposal to ensure automatic austerity if budgetary guidelines are exceeded in the single-currency bloc, but monetary officials expect it to come soon.

Even German Chancellor Helmut Kohl, whose enthusiasm for the whole project outweighs that of his financial experts, was reported this week to be more concerned that a stable and secure single currency appears by around the turn of the century than that the January 1999 deadline is met.

Such a delay could be on the cards now that countries will be judged on the economic performance in 1997, as the Valencia meeting decided. Only Germany and Luxembourg are certain to meet the targets on inflation, budgetary discipline, currency stability, low long-term interest rates and government debt levels on a mechanically strict reading.

However, the infamous rule that public debt should be reduced towards 60&percent; of gross domestic product “at a satisfactory pace” is sufficiently vague to make the final choice of union members uncertain until the last minute. On this basis, at least the Netherlands, Austria and Ireland should join the club.

The biggest question marks hang over France and Belgium. France is racing to meet the target of cutting the budget deficit to 3&percent; of GDP in time, while Belgium could just make it for 1996, but will still have a pile of public debt worth 131&percent; of GDP.

While Madrid can paint the most efficient scenario for setting up a currency union, the crucial political test will come two years from now.